As we gradually put the Great Recession in the rearview mirror, we now focus on a critical next step: normalizing interest rates ― aka a rate hike. Most observers expect the Federal Reserve to initially increase the fed funds rate by just a quarter of a percent, perhaps as early as September. We agree: even as it remains data-dependent, the Fed should find no excuse for not raising rates by the end of the year.
Two key items the Fed is surely watching are continued improvements in job creation and lower levels of unemployment. The good news is that there is strong and persistent progress on both fronts. As the chart indicates, the most recent non-farm payrolls report in July indicated an additional 215,000 jobs (13% over its 5-year long-term average). Unemployment continues to trend lower and currently sits at a 7-year low of 5.3% (down from a peak of 10.0% in October 2009). More jobs and lower unemployment naturally extend and are inexorably linked to consumer behavior and activity.
As we know, the consumer still represents just under 70% of the U.S. economy, so the Fed clearly has an eye on that as well. While some readings are erratic, there are signs of improvement that confirm a generally positive trend. One example is consumer lending: the most recent Federal Reserve Senior Loan Officer Survey indicates banks are incrementally loosening credit conditions. Indeed, the survey shows a 10.4% increase in respondents willing to make consumer loans in the second quarter (up from increases of 8.3% in the first quarter and 4.4% in the fourth quarter of 2014). This supply increase is occurring alongside steady loan demand from increasingly confident consumers. Relatedly, there has been an expansion in consumer credit.
Other metrics/tailwinds such as strong auto sales, lowered gasoline prices and still relatively low mortgage rates, etc., support continued willingness to spend and growth in overall consumer confidence.
The good news in the U.S. is not lost on the Multi-Asset Solutions Team: we feel this data supports our view that the U.S. economy looks closer to mid-cycle than late-cycle. That said, our modest overweight to global equities remains tilted to non-U.S. equities (relative to benchmark). This positioning is based on the mix of valuation, economic and policy data we have discussed in Strategy Spotlights since we initiated this position in February.